Bob makes a historical/cultural/pop culture reference and Alice thinks he is referring to something entirely different. Bob corrects Alice but this only leads to another correction, which only confuses Alice again. Bob makes another correction and so on and so on.
Just one mistake and this would just a simple misunderstanding, however string together a chain of these and Hilarity Ensues.
Due to the nature of this trope with multiple cultural references in quick succession, some of the allusions may fly over the audience's head. This usually doesn't actually hurt the comedic potential though.
See Who's On First? for this trope dealing solely with people with unfortunately confusing names.
Abbott and Costello's famous "Who's On First?" comedy routine, where Abbott tries identifying the players of a baseball team to Costello, but Costello's constant misinterpretation of the players' names and nicknames as non-responsive answers leads to Abbott constantly invoking the trope ... and leaving Costello even more confused and frustrated!
London: Too late, we're gonna get married, buy a big villa, and live in Acapella.
Maddie: People sing A Capella; he lives in Acapulco.
London: That's what my sweater's made out of.
Maddie: That's Alpaca!
Newspaper Comics
A Sunday strip of Pickles did this once. Two of the main characters did this in order to drive a third character to leave the bench they were sitting on.
On Fibber McGee and Molly, the character of Mayor LaTrivia was subjected to these practically Once Per Episode. They'd usually involve him innocently using some figure of speech, which Fibber or Molly (or both) would either take too literally or otherwise misinterpret, sometimes on purpose. LaTrivia's subsequent attempts to clear things up would only create more confusion, making him increasingly flustered and confused and generally reducing him to sputtering, incoherent rage by the time his visit was over.
One not involving Mayor LaTrivia, from "Cleaning the Closet":
Fibber: Remember that spring we were up there, and those people were selling flowers on the street corner? Trailing arthritis, I think they were.
Molly: You don't mean trailing arthritis, you mean trailing arbutus[1].
Fibber: I do not; Arbutus was a guy in Shakespeare. He's the guy who stabbed Caesar in the toga.
Molly: No, that was Brutus.
Fibber: No, you're thinking of that fairy tale: Puss and Brutus.
Molly: No, you that wasn't Puss and Brutus, and what you mean is arbutus.
Fibber: If that's arbutus, what's arthritis?
Molly: Arthritis is when your joints swell.
Fibber: Well, that's what I say. Any place that sells flowers on every street corner is a swell joint.
According to Gabe on the podcasts, most people blame Tycho for those, even though it's his "favorite joke, ever." From the third series of D&D podcasts:
DM: ... and he has a cataract in his left eye.
Gabe: A boat?
Tycho: That's a catamaran.
Played with in Darths and Droids with Jim. He's wrong more than he's right though.
I'm sorry, it was Tom Berenger, we were looking for Tom Berenger.
also:
Lois: Okay, one more minute, and then if there are two pink lines...
Peter: Oh god, I hope you're not pregnant, we can't afford another kid. We already got Chris, Stewie, Richie, Joanie, Greg, Marsha, Bobby, Jan, Mike Seaver, Carol Seaver, Boner, Urkel, Mr. Furley...
Brian: Peter those aren't your kids, that's the Nick at Nite lineup.
Peter: Blanka, Zangeif, Chun-Li, Guile, E. Honda...