Are you suggesting that PE should have different grading procedures than other subjects (which reward measured results, or at least in my school did)? Or are you even suggesting in general that all subjects should be graded like this (and for example someone really bad at math but "trying really hard" should actually be getting A's and B's)?
Oh and in primary school, teachers would go in the teachers lounge to smoke while they were given a break by us being in PE.
For PE we had normatives we were supposed to meet -- so many pullups, etc (based on old soviet army normatives I think :)), and if you don't you got corresponding grade.
I would make sense to break PE course into two -- one about theory and one about skill and have two separate grades for them.
Of course, you could establish a similar grading schemes for physical education, but that would essentially look like grading based on effort and participation.