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If you are using an HDMI cable to send both picture & sound (as required by the newest audio formats supported by Blu-Ray players), then if you want your audio receiver to receive and reproduce those newer audio formats then yes, the receiver has to offer the audio decoding for the newer formats. The good news is that most new receivers do. Dolby TrueHD, DTS Master Audio...
You don't necessarily need your receiver to 'upscale', which is a term used to discuss a variety of video processing but which generally means that a device is taking a lower resolution signal and processing it to a higher resolution output. Some devices do it well, some do it badly. It all depends. That's why other people here have mentioned separate (outboard) scalers. Companies like DVDO or Gefen make them. Will they improve your image? Often they will. For some people they will be worth it.
I've seen some "upconverting" DVD players where the images didn't seem that different or better on the TV screen when switched to different output resolutions (480i / 480p / 720p / 1080i). On the other hand, others did much better. I've also seen older but really high end 480p DVD players' images look better than newer, cheap "upconverting" players.
When people use terms like "upconvert" and "transcode" with regard to audio receivers, most of the time, though, they're talking about the receiver's ability to take an analog input (component video, s-video, composite video) and output it through a single HDMI cable.
HDTV's also have their own built-in 'upscaling', meaning that a 1080p TV will process a lower resolution to be shown on a 1080p screen.