Okay, let me try my hand at this one. (This stuff is complex as all get out, so don't feel bad if you don't quite understand it from the get-go. It took me a few weeks to get this down pat. I'm still not the most knowledgeable, but I try!)
Natural sound has no bit-rate, obviously. It's impossible to measure a face to face conversation in kilobytes per second (kbps). So why do we even have them? We have bit-rates because of the technical incapability of our technology to perfectly recreate sound. Computers work in a language called binary, which is essentially a very large amount of 1s and 0s. The real world doesn't. But, through magic itself, sound engineers have found a way to turn natural sounds into 1s and 0s. These 1s and 0s are called bits.
Now, let's take a look at CDs. CD's are no different than a flash drive, a hard drive, a memory stick, or any of that stuff. Music CD's store music files in digital formats that CD players and computers can understand. Because CDs are fairly large medium (700 MB, compared to the typical 40 MB of an album of low-bitrate MP3s), they can store very large files. A file on a CD typically has a bitrate of over 1400!
So how do MP3s do it? Well, they use a technique called compression.
An MP3 encoder's job is to take these HUGE files (that I tolerate and put up with and think sound AWESOME) and turn them into smaller files. They do this by cutting the bit rate. But what is a bit rate? A bit rate is the number of bits that a computer processes into audio per second. Want to know a video game with a high amount of graphics "bits"? Skyrim. Want to know a game with a low amount of graphics "bits"? Pong.
While this comparison is probably very, very wrong, I think it serves a good point. The more bits get removed from a picture, video, or audio file, the less detailed it becomes. If a passage in a 1400kbps (14000 x 1000 bytes per second) file goes "11010001", an MP3 encoder might change it into "10". Why? Because in the pursuit of making things small, it sees that the first half of the passage has a lot of ones, and the second half has a lot of 0s.
TLR Using a low-bitrate MP3 is like playing Skyrim on an old tube TV. Using a high-bitrate FLAC/WAV/CD is like playing it on a movie theater IMAX screen. Both have their purposes, but you know which one looks/sounds better.
So, as to your question about why taking a low-bitrate MP3 and turning into a 320 kbps MP3 doesn't work well. Consider the following.
The file was already converted into 128kbps (I assume.). It's already gone from 11010001 to 10. If you up the bitrate, and make the 10 bigger, it's just going to turn into 11110000. Problem is, it started as 11010001. If the computer is starting at 10, how is it going to know that there was 0 in between the ones and a 1 at the end of the zeroes? The solution to this is to get your music from sources that are at least as high-bitrate as you would like. You can turn a 1400kbps CD into a 320 kbps MP3 pretty easily. The opposite just doesn't work.
TLR A 1400kbps file sounds better than a 320kbps file. A 1400kbps file that started as a 320kbps file isn't going to sound any different (unless your encoder's bad, in which case it will sound worse). You can't polish a turd.
With either a high-bitrate or low-bitrate file, a computer or CD player or iPod has to turn these ones and zeros into audio. A CD that said, "1010101010101010" probably wouldn't sell well (but would still be better than anything Lil' Wayne has ever made, ever.) This is where a DAC comes in. DACs, which stand for Digital to Analog Converters, take the digital 1s and 0s and turn them into analog audio. These DACs are electrical components. The DACs of most soundcards in computers are next to...well...computer stuff. Electric stuff plus electric stuff on top of electric stuff causes interference, which often results in static and hissing noises and other nasty stuff. A separate DAC stays away from all of the stuff that causes interference and often has higher quality electronics and circuitry.
TLR DACs turn computer files into audio. Every electronic piece of equipment that plays MP3s and WAVs and all that other stuff has a DAC. The quality of these varies. DACs and computer internals often cause interference, which in turn causes static. Having a DAC that is separate from the inside of your computer gets rid of this.
Disclaimer: William (CashNotCredit) takes no responsibility for the accuracy of the above content, and it is probably very, very wrong. Don't listen to him. Just smile and turn away.