It can sound great but it all depends on the quality of the MP3 files you are using. Low bit rate files at 128 and such will sound poor. If you use 256,320 or lossless you will get great sound. Not like a good CD player but quite good.
Rate for rate, AAC sounds better than MP3 from an iPod. You can either plug the iPod in using an interconnect with 3.5mm jack to 2 RCAs (phonos). Or you can connect something like an Onkyo base which also allows you to remote control the iPod...