It does passthrough dolby digital now I think, there is also an option in the sound for dolby digital now, but not DTS. Some files don't even play sound with a certain audio codec ( probably DTS ) Also the scaling on the USB playthrough is a bit wonky, letterbox bars were wider than they should be. Watching movies is best with blu-ray player, htpc, console, mediaplayer or normal tv ofcourse. The internal system isn't all that great for playback in my opinion.
Regarding ISO files, I haven't tried but I'm pretty sure it won't play that.