(I do not have any dev android phone and currently working on emulator only. As the emulator do not have voice input method, these silly question came up in my mind.)
Does android process speech input on the device itsself (with limited computing power of 300-500MHz or 1 GHz) or it sends to Google Serves and gets text back?
No, the actual speech to text is done on Google's servers, your phone just records the data and sends it to them. It does not work when offline.