I have 3.2 version.

The Pages Menu in the left sidebar is showing all pages even though I have the depth set to 1. I tried excluding pages also but that doesn't work either.

I really only want the main "categories" listed under Pages. Then when you click on that main title all the other ones connected to it.

Is this a bug fixed in later versions? Also, how do I update the older version without losing all my settings.

The default WP pages widget is not controlled by Atahualpa but you can try the Flexipages widget or another plugin