Ok, we're not on the same page here. I'm just explaining why some of the picture is being cut off when you have it in full-screen, or why there are black bars on the top and bottom if you don't. I guess you never mentioned that you have the black bars when you are watching Gladiator, but I'm assuming you do when you're not in full-screen.
I just looked it up, and the aspect ratio of Gladiator is 2.35:1. So this means that at a set width of 480 pixels, the picture will be about 204 pixels high. Therefore, each of the black bars will be 58 pixels high on top and bottom. Also, if you set the height at 320 pixels, then the picture should be about 752 pixels wide. If I'm doing my math correctly, 136 pixels are being cut off from each side when you are watching Gladiator in full-screen mode.
Now, I'm guessing that Handbrake, or any other encoder, is setting the width of the picture at 480. It leaves the height as a variable based on whatever the aspect ratio of the source is. If you are manually setting both the width and height (480x320) for a source that is not in that proportion, then screwy things are going to happen. Namely, the picture will be distorted.
The moral of the story is that you should leave the default "Iphone/Ipod Touch" setting alone as far as the width/height is concerned. Yes, this will cause black bars or cropping of the picture, depending how you're viewing it. But the picture will not be distorted.
Now let me caveat this by saying that I've used Handbrake for all of two days. What I wrote is based on what I think is correct. If I'm wrong, please let me know.