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Take the example of a Dolby Digital signal on a DVD. This is a compressed format, it takes 10mb of info and squeezes it down to 1mb (numbers totally made up, actual compression ratio varies). So, in order turn a 1mb chunk of Dolby Digital into audio you can hear, it needs to be uncompressed back into 10mb.

That decompression, or decoding, can usually take place in one of two locations, 1) the dvd player, or 2) your receiver. When it is decoded in the player, 10mb of linear PCM will be sent to your receiver and then played with no further decoding. When it is decoded in the receiver, the player sends out 1mb of bitstream output, which is turned into 10mb in the receiver.

So, which sounds best? Well, if your AVR doesn't decode the bitstream format you're sending it (Dolby TrueHD for instance), you won't get any sound at all, until you switch to Linear PCM. Now, your 705 will decode DDTHD and many other codecs, so why wouldn't you want to just send everything bitstream?

Well, on Blu-ray movies, the menus have little button clicks and swooshes. These are only audible when the decoding is done in the player, these sounds are mixed in, and the whole mess is sent out Linear PCM. If you won't miss the clicks and boops, allowing your receiver to do the decoding can be a simpler setup.
 
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