DonMich: I do NOT have a PS3, but I believe that your answer may be in the AVS PS3 forum:
From the XMB Settings menu there are two drop down menus that you will need to check.
* First there is the "Video Settings" menu ("Video Settings" was called "BD/DVD Settings" with PS3 firmware prior to version 2.50 and includes items related to audio as well as video) which includes a sub-menu for setting the audio output format (with sub-menus for each HDMI and Optical outputs).
Also from the XMB Settings menu there is a drop down menu for "Sound Settings" and it is here that you select to have the audio output via either HDMI or Optical (one or the other, not both, can be selected for PS3 firmware versions prior to 3.00) with sub-menus under each for selecting the specific audio formats to be supported for that type of output. Starting with PS3 firmware version 3.00 multiple audio outputs can be active simultaneously. For this new feature, a new menu item has been added under the "Sound Settings" menu for "Audio Multi-Output". With this option set to "ON" the PS3 audio will be simutaneously output on multiple outputs (e.g., HDMI and optical).[/list]In most cases you should set your PS3 to output Bitstream if you are using an optical digital connection (i.e., Toslink) from the PS3 to your Audio/Video Receiver (AVR), and you should set it to LPCM if you using a HDMI connection to an AVR (see below if you have the newer "PS3 Slim" model). These are the default settings.
Unless you have the newer "PS3 Slim" model, the PS3 will not bitstream advanced audio formats to your AVR (i.e., it can only bitstream basic Dolby Digital and DTS surround audio formats). All models of the PS3 can decode all of the Blu-ray Disc standard and optional audio formats and convert them to multichannel LPCM and pass that to your AVR via HDMI. Note however that the optical audio output from the PS3 (or any other Blu-ray Disc player), can never support the new high resolution (i.e., lossless) surround sound audio formats. Thus, to get the full advantage from the superior performance from the high resolution audio formats offered on BD, as compared to DVD, you must connect your PS3 to an AVR that has HDMI inputs. If you are using one of the orginal models of the PS3 (i.e., not the PS3 Slim) then the AVR must accept multichannel LPCM via a HDMI input (most AVRs that have HDMI inputs can do this except for a very few low-end models). If you are using the newer PS3 Slim model then it can be configured to either output the lossless audio in bitstream mode or to perform the decoding and output the lossless audio in LPCM mode via the HDMI output on the PS3. In order to use the bitstream mode on the PS3 Slim your AVR will need to both have an available HDMI input and be able to decode the lossless audio formats, including Dolby TrueHD and DTS HD-Master Audio.
The PS3 console has three types of audio outputs. The advanced high resolution Dolby, DTS and multi-channel PCM surround audio formats are only fully supported when using the HDMI output. However, if you are willing to live with just a 2-channel output in PCM (rather than the full surround sound formats) the improved fidelity offered by the advanced high resolution audio formats can be provided via the optical digital audio and even the analog audio outputs. Also Standard Dolby and DTS surround formats (as used on DVDs) can be output via the optical (Toslink) digital audio connection in bitstream format. The following table shows what audio format is output for each type of connection for the different audio formats that may be found on BDs, DVD, and SACD (Super Audio CDs).
The full link is here:http://www.avsforum.com/avs-vb/showthread.php?t=931796