I posted this earlier in the amp section for you.
DAC = Digital to analog converter.
It is what your devices uses to interpret the digital music, cd, mp3s, In other words, it is the device that makes music from the series of numbers that digital music is encoded at.
So....mp3 or CD (series of numbers) ----> DAC (takes series of numbers and makes it into something the headphones can use --->amp (makes that signal louder)---->headphones or speakers
So as you can see, if you really want great sound, every piece in that chain needs to be good. If you have a really good set of headphones and dac but use lousy source (cd player, mp3 player), or if it's encoded crappy, you're just gonna be ampin up the crappiness.
That is why you hear everyone here talk about what bit rate they encode at etc... Stuff that you find on like pandora is around 128 bps (or less). CD quality is the best. I typically encode all my mp3s @ ~320 - lossless.
Now understand this... every consumer source (cd player, mp3 player) already has a built in DAC and a opamp (operation amplifier) that allows you to listen to music. You're just bypassing their AMP and DAC to your headphones. Also your device needs to have a line out otherwise, you'll just be amplifying what that device has already amped.