Actually it sets the cluster size to 32K. Each sector on a harddrive is 512 bytes, so if you want a 32K cluster it's 512 bytes x 64, which gives you 32Kilobyte. (1 kilobyte = 1024K, 512 x 64 = 32768. 32768 / 1024 = 32).
In otherwords, a cluster is a group of sectors. It's better for audio and video app's because your usually working with larger chunks of data. So, should give a bit better hard drive performance (not night and day, but every bit counts.)
You set up the FAT when you run FDISK, if you want FAT 32, select FAT 32, if you want FAT 16 partition accordingly.