I am currently experiencing the exact same issue with my Power Mac 7300/200 running system 8.5. Every floppy I have tried (2S2D, 2SHD mac formatted, 2SHD IBM formatted) fails to initialize. Every once in a while, it will decide to read an IBM formatted disk that was already formatted on another computer. But very, very rarely.
Interestingly, I ran across this:
http://www.mug.jhmi.edu/mirrors/infoalley/0896/29/power.html
http://www.mug.jhmi.edu/mirrors/infoalley/0896/29/power.html"]http://www.mug.jhmi.edu/mirrors/infoalley/0896/29/power.html
Summary:
You likely need to reinstall the Power Mac Format Patch, which corrects the problems that you are experiencing with floppy disks. The Power Mac Format Patch is required on any Power Macintosh 7500, 7600, 8500, or 9500 computer with a 180 MHz or faster PowerPC processor.
Further reading indicates that any 604x processor running at 180mhz or faster needs this "Power Mac Format Patch" patch. This could also be what you are experiencing?
I can't find this patch anywhere. Has anyone experienced this, and knows where to find this patch?