When you take words that sound the same and put them together to make a completely different sentence. Can also be used when someone miss-hears you and questions what you said with what they thought they heard.
First example and definition derived from the All bran advertisements.
Guy1: "Yum, this all bran is delicious"
Guy2: "What?! Tall Jan is malicious!"
Guy1: "I've composed a riddle"
Guy2: "You've exposed your diddle?!"