The teacher is well aware of the students abilities, efforts, and attitude. Not only physical ability, but also the effort that is applied, and the attitude of the student are part of the grading process. From what I understand, the grading is on the individuals progress, not a comparison to others. If you are looking at someone who has a really hard time with their body, but has progressed a long way from when they first started training; then that is the benchmark that this person is being graded on. Also, you have some very physically talented people who have problems with their arrogance and attitude, who might be physically at a certain level, but who are not there yet from a maturity level.
This is just my $.02. I would love to hear what others have to say about this.