The short answer is that the area classification is the logical division of your product or project, and the iteration classification is its chronological breakdown into releases and development iterations.
The area path describes the logical part of the system that your work item relates to, e. g., which module or subsystem some bug was found in.
Likewise, the iteration path tells you which iteration put release a work item should be handled in, for example, this task is for the third iteration of the fifth release.
The logical and chronological breakdowns can be done any way that makes sense to your team, as long add the structure remains that of a tree.
Does this help?
Assaf.