A texture atlas is a larger texture, which is split by a given grid in smaller icons. As the name says, textures are defined at assets/textures with the .png extension and an atlas is defined at assets/atlas as textfile with .atlas extension.

Example

Following is an example from the module ManualLabor :

ManualLabor.png

ManualLabor.atlas

{
    "texture":"ManualLabor",
    "textureSize":[256, 256],
    "grid":{
        "tileSize":[32, 32],
        "gridDimensions":[8, 8],
        "tileNames":[
            "ShovelHead", "PickaxeHead", "AxeHead", "SledgeHammerHead", "", "", "Time", "Heat",
            "MetalFileHandle", "ScrewdriverHandle", "Wrench", "SawHandle", "PliersHandle", "MagnifyingGlass", "", "",
            "MetalFileHead", "ScrewdriverHead", "Key", "SawHead", "PliersHead", "MalletHead", "", "",
            "CrudeHammer", "CrudeAxe", "Cloth", "String", "CrudeShovel", "MalletHandle", "", "",
            "Stick", "Plank", "Pegs", "WoolVest", "ArabicThawb", "Waterskin", "WaterskinEmpty", "",
            "PlantMatter", "WoodenBucket", "WoodenBucketFluid", "WoodenCup", "WoodenCupFluid", "", "WoodenShoe", "",
            "", "SmallChunks", "SmallDust", "", "", "", "", "",
            "Nugget", "Chunks", "Dust", "Sheet", "Plate", "Rod", "Bolt", "Screw"
        ]
    }
}

So the prefab for a key in ManualLabor would be as follows :

{
  "parent": "engine:iconItem",
  "Item": {
    "icon": "ManualLabor:ManualLabor#Key",
    "stackId": "ManualLabor:Key"
  },
  "DisplayName": {
    "name": "Key"
  },
  "MaterialItem": {
    "icon": "ManualLabor:ManualLabor#Key"
  }
}

The key then uses the texture mentioned in the atlas with the # symbol ; "icon": "ManualLabor:ManualLabor#Key"