The processor is a decent GPU with a ARM core cpu tagged into it. RPi foundation paid for licensing H264, but licensing mpeg would have added to the price - AFAIK Mpeg decode functionality is there in the GPU but is locked, therefore the ARM core will soft decode it.
Latest news, for £2.40 you can now get the hardware decode Mpeg functionality - see http://www.raspberrypi.org/archives/1839.
They also discovered that H.264 encode was already covered with the H264 playback licence. Great news, now I just need support of the $5 webcams that proliferate on ebay.