Processing can be anything; deinterlacing, noise filtering, resizing, colour correction, etc...
There are many filters built in to AviSynth, and many more can be downloaded as plugins.
When you select an AVS file as the source for CCE, TMPGEnc or whatever, the encoder sees the AVS file as a normal AVI file. Since AVISynth takes the source video, processes it, and serves the processed frames to the encoder, there is no requirement to save an intermediate file.
It is a very powerful piece of software, and it is worthwhile learning how to write scripts.