AAC: MPEG-4 Audio.
AAC, which stands for Advanced Audio Coding, part of the MPEG-4 specification, is a powerful, high-quality audio codec designed to compress audio files to smaller sizes than MP3, while delivering a better quality.

Crystal clear sound at smaller file sizes.
According to Apple, expert listeners have judged AAC audio files compressed at 128 kbps (stereo) to be virtually indistinguishable from the original uncompressed audio source, whereas MP3 files at the same bitrate (taking up the same amount of space on your disk) contain audible artifacts.
In general, AAC-encoded files sound as good as, or better than, MP3 files encoded at the same or even a higher bit rate.

AAC takes full advantage of state-of-the-art signal processing technology from Dolby Laboratories and proves itself worthy of replacing MP3 as the new Internet audio standard.

For more information on AAC, you can visit the AAC website or Apple's AAC page.

AAC, your Mac and your iPod.
AAC audio files are supported by iTunes 4 and the iPod. Make sure your iPod is updated to software version 1.3 in order to enable playback of AAC audio files.

 

Better sounding.
Tests have been conducted in order to evaluate the performance of AAC encoding. Of course, the quality of the resulting sound depends on the bit rate being used and other details such as the coder variant being used (Low Delay AAC, TwinVQ base with AAC enhancement, etc.). On a subjective scale ranging from 1 (low quality, bad artifacts) to 5 (excellent quality), AAC audio at 96 kbps resulted in a better and cleaner sound (score 4.4) than MP3 at 128 kbps (score 4.1). You can read the entire paper on Telecom Italia Lab's web site.

RecordStoreReview has an interesting report on AAC vs. MP3 which you might want to read as well.

 

3GPP: audio on your cell phone too.
3GPP, also based on the MPEG-4 standard, encodes files at very low bitrates for sharing with 3G cell phones or streaming over low-bandwidth connections. But even desktop computer users can take advantage of 3GPP's high compression, for encoding speech in very small files.
For more information on 3GPP, read Apple's 3GPP page.

To encode audio and other media to 3GPP format, make sure you have installed QuickTime version 6.4 or later.