Generation 1 iPod folklore held that the battery indicator would work better if the iPod was reset once and a while (when charging, press & hold MENU+Hold for over 2 seconds). Later releases of the software did improve the accuracy of the display, as you noted.
Even with version 1.4 software, this procedure still seems to prevent the iPod from deciding the battery is dead before its time. My iPod battery is still good for casual use (several hours), but time to replace it is clearly destined by its 3rd birthday.
Still, this seems like pretty good service.