IP Fragmentation

Encapsulation:
When a host or router handles a datagram, the IP software determines the next hop to which the datagram should be sent. Thus a datagram could traverse many physical networks, each with their own frame formats. An IP datagram is encapsulated in the data area of the frame.

MTU:
The basic fact in networking is that not all networking technologies were created equal. One of the differences between various layer-2 technologies is the maximum payload (commonly called Maximum Transmission Unit – MTU) a layer-2 frame can transport.

Fragmentation:
IP uses a technique called fragmentation to solve the problem of heterogeneous MTUs. When a datagram is larger than the MTU of the network over which it must be sent, it is divided into smaller fragments which are each sent separately.

Path MTU Discovery: The generic solution to the IP fragmentation issues should be the Path MTU Discovery that was issued as an RFC.
It works by setting the DF (Don't Fragment) option in the IP headers of outgoing packets. Any device along the path whose MTU is smaller than the packet will drop such packets and send back an ICMP "Destination Unreachable (Datagram Too Big)" message containing its MTU, allowing the source host to reduce its assumed path MTU appropriately. The process repeats until the MTU is small enough to traverse the entire path without fragmentation.

References:
http://penguin.dcs.bbk.ac.uk/academic/networks/network-layer/fragmentation/index.php
http://www-inteng.fnal.gov/Integrated_Eng/software/locsys/syscode/ipsoftware/IPFragmentation.html
http://www.nil.si/ipcorner/IP_Fragmentation/