It adds one additional year.
Ya... meaning two years from the original purchase date...
And to answer your other question: The AppleCare Protection Plan can be purchased only while your iPod is still covered under the standard one-year limited warranty. (From Apple)
I don't want to talk you out of it, but one extra year for $59? Seems too expensive...
What I would do is save the $59, and use it towards buying a new model in 1 or 2 years from now when they have a new iPod that your going to wanna buy...
However, an iPod touch battery replacement costs $74 so if your planning on replacing the battery... it might be worth it. But beware that it's subject to Apple's approval that the battery can hold less than 50% of the original...