How do armor enhancements work?

Solution 1:

The game manual states

You can only upgrade those items that contain slots for runes and enhancements. When you own such a sword or armor and an upgrade, enter the equipment panel and drag the upgrade in question to a chosen item - it will be upgraded. You cannot undo an upgrade.

The upgrade slots appear as circles to the left of the item on the inventory screen. They are open if the slot is unused and filled if an enhancement is present.

(This weapon has an empty slot)

(This armor has been enhanced)

Solution 2:

According to the in-game help, you can only add enhancements to armor with an enhancement slot in the first place.

Near as I can figure, it's basically a version of the Diablo-esque socketing system, except instead of gemstones, you apply the enhancements instead.

(As to why they drop before you have armor with enhancement slots, who knows?)