The 16-year-old Patterson put on a fearless display to win the title with a score of 38.387 and emulate the feat of compatriot Mary Lou Retton at Los Angeles in 1984.
Khorkina, favourite for the title and competing in her third and final Olympics, failed to match her young rival and was edged out by 0.176 of a point to finish second.
Patterson's victory allowed her to avenge her defeat by Khorkina at last year's world championships and complete an American sweep of the all-round competition after Paul Hamm had grabbed the men's title a day earlier.
"You dream about this your whole life and then you win the gold medal and it's just amazing," said an emotional Patterson.
Zhang Nan won the bronze to capture China's first gymnastics medal in Athens.
Patterson had trailed in eighth place after the first rotation, having gained a deduction from the judges for her hopped landing following her double twisting Yurchenko vault.
But by the time she showed off her balancing skills in the third round, she had leapfrogged Khorkina to the top and there was no stopping her.
Her dazzling display on the beam included a full twisting back somersault, and her solid dismount was greeted by a loud roar in the arena and an equally high score of 9.725.
The last competitor to perform the floor exercise, the American teenager knew she had to score higher than 9.536 to beat Khorkina.
Patterson performed the routine of her young life, landing each of three linked tumbling combinations to perfection.
As the music ended, Patterson tearfully fell into the arms of her coach and the crowd leaped to their feet.
A score of 9.712 handed Patterson the gold, leaving the 25-year-old Khorkina to reflect on her third failed attempt to grab the top individual prize.
"I told Carly not to worry about the scores. I told her 'You have got to compete with yourself, not with Svetlana, not with anyone'," said her coach Yevgeny Marchenko.
"Being the last person in a competition is a lot of pressure, she proved she could handle that pressure."
Earlier, Khorkina had finally erased painful memories from four years ago when an incorrect vault setting ruined her title hopes at the Sydney Games.
The apparatus has often been the bane of her life but this time Khorkina smiled confidently as soon as she nailed the intricate combination she had invented.
But the judges were unable to agree on a score and left Khorkina waiting for more than five minutes before a mark of 9.462 finally flashed up, leaving her in fifth place.
Her intricate combinations on her signature apparatus, the asymmetric bars, lived up to expectations and Khorkina jumped to the top of the leaderboard with 9.725.
But a major wobble on the balance beam contributed to a mark of 9.462 which allowed Patterson to seize the lead.
Carly Patterson upstaged Russian diva Svetlana Khorkina to become the first American in 20 years to win the women's Olympic gymnastics all-round gold medal on Thursday.
The 16-year-old Patterson put on a fearless display to win the title with a score of 38.387 and emulate the feat of compatriot Mary Lou Retton at Los Angeles in 1984.
Khorkina, favourite for the title and competing in her third and final Olympics, failed to match her young rival and was edged out by 0.176 of a point to finish second.
Patterson's victory allowed her to avenge her defeat by Khorkina at last year's world championships and complete an American sweep of the all-round competition after Paul Hamm had grabbed the men's title a day earlier.
"You dream about this your whole life and then you win the gold medal and it's just amazing," said an emotional Patterson.
Zhang Nan won the bronze to capture China's first gymnastics medal in Athens.
Patterson had trailed in eighth place after the first rotation, having gained a deduction from the judges for her hopped landing following her double twisting Yurchenko vault.
But by the time she showed off her balancing skills in the third round, she had leapfrogged Khorkina to the top and there was no stopping her.
Her dazzling display on the beam included a full twisting back somersault, and a loud roar in the arena and an equally high score of 9.725 greeted her solid dismount.
The last competitor to perform the floor exercise, the American teenager knew she had to score higher than 9.536 to beat Khorkina.
Patterson performed the routine of her young life, landing each of three linked tumbling combinations to perfection.
As the music ended, Patterson tearfully fell into the arms of her coach and the crowd leaped to their feet.
A score of 9.712 handed Patterson the gold, leaving the 25-year-old Khorkina to reflect on her third failed attempt to grab the top individual prize.
"I told Carly not to worry about the scores. I told her 'You have got to compete with yourself, not with Svetlana, not with anyone'," said her coach Yevgeny Marchenko.
"Being the last person in a competition is a lot of pressure, she proved she could handle that pressure."
Earlier, Khorkina had finally erased painful memories from four years ago when an incorrect vault setting ruined her title hopes at the Sydney Games.
The apparatus has often been the bane of her life but this time Khorkina smiled confidently as soon as she nailed the intricate combination she had invented.
But the judges were unable to agree on a score and left Khorkina waiting for more than five minutes before a mark of 9.462 finally flashed up, leaving her in fifth place.
Her intricate combinations on her signature apparatus, the asymmetric bars, lived up to expectations and Khorkina jumped to the top of the leader board with 9.725.
But a major wobble on the balance beam contributed to a mark of 9.462, which allowed Patterson to seize the lead.
