Hi Greg,
This issue is a bit confusing, but I’ll try to clarify:
A) Unless you’re doing easily-resizable vector/shape graphics (Illustrator, Fireworks, or even Photoshop vector art), you’re wise to design everything HUGE (iPad3 resolution) and then scale down. I think iPad3 (2048x1536) is the maximum practical level to be concerned with, since it’s even bigger than many desktop/laptop resolutions (so, let’s say Corona eventually expanded to run on both mobile devices AND native OSX or in web browsers, you’d be covered).
B/D) the value “704” that I use in my config is confusing at first. I actually chose it because it’s directly between the iPad width (768) and the iPhone4 width (640)… 768-640=128 … 128/2=64 … 768-64=704. So you’re correct, 704 is sort of the value that I use to weigh my scaling “factors” against.
Look at the example config code in my previous response and note the commented lines. This shows exactly how I got those scaling factors. Remember that Corona will look for the next-lowest or equal value when choosing what images to use with newImageRect(). If 3 different devices return scaling factors of 0.8, 0.82, and 0.93, they’ll all use the “0.8” scaling factor that you defined… but if a device returns 0.799999, it will use the next lowest factor, assuming you specify one.
By the way, you can easily get a device’s "scaling factor"in the Simulator, using this:
print(1/display.contentScaleX, 1/display.contentScaleY)
C) This one is tricky. I actually design my graphics with 1024 x 704 in mind. And I design 3 sizes of graphics overall. Again, note how I set up the factors and grouped them as _1, _2, and _3. The commented lines above each factor show which device(s) will use it.
So why 704, and not 640 or 768? I simply consider 1024 x 704 to be my base 1x screen resolution. My images will undergo no in-device scaling on iPad1/2/3. They will be scaled down very slightly on iPhone4 or Kindle/Nook, but that’s fine (better to scale down than up!)
The best way to see what’s happening is to use my config settings in a new project, then display and center a rectangle on the screen:
local screen = display.newRect( 0, 0, 1024, 704 )
screen.x = 512 --1024/2
screen.y = 352 --704/2
screen:setFillColor( 255, 0, 0, 200 )
Now run this is all of the Simulator device modes and you can see how the rectangle (the “screen size”) fits within the bounds of all of them, with various amounts of “letterboxing” on the edges. This is the empty area you’ll need to deal with (and there are simple ways)… but basically you can see that the entire 1x screen will fit within the device at all times.
E) Correct, I don’t use a “base” image file. I suffix every image with either _1, _2, or _3. Of course you can name these anything you want… @1, @2, @3, even _USE_ME_FOR_IPAD3, but that would look silly in your project directory. 
Hope this helps. Running the actual config with the colored rectangle explains it better. Oh, and if you need certain things like GUI bars or elements to always adhere to an edge of the screen (adjusting per-device), I can show you the simple formula to achieve that.
Brent Sorrentino
Ignis Design
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