Transcoding is done on the server to put the video stream into a format your player can play. If the player can play the raw format, transcoding is not needed, if it can't, transcoding is done on the server - basically what I'm saying is it's never done on the client. If you have a powerful HTPC that can play any format and software that can decode the file formats you media is in, you'll never need to transcode.
Long time Plex user, and yes, Plex will transcod when it needs to, and Direct Play when it can. Transcoding really isn't that big an issue if your server is any bit powerful. I have a i3-2100 in my unraid server and it can transcode 2 streams at the same time without issues (maybe 3.. I've just never tried it). I agree it should be avoided if not needed, but I have an HTPC at my main 46" TV running the Plex client so any 1080p/5.1 content running there is not transcoded. Pretty much everything to my ATV in the bedroom or the den is transcoded to 720/2.0, and everything to the iPad is transcoded - all done on the server.
I'm not disagreeing with everyone who says it's best not to transcode if you don't have to, but I have never had ANY issues with it, and having the ability to transcode means you add lightweight clients (ATV or smart TV) to your system and not be limited in the content you can play.