Created attachment 40457 [details]
test program for the describted behaviour

how to reproduce:
download test environment from Comment 1

tar -xvzf kreadconfig.tgz
cd kreadconfig
./kread-desktopfile-test.sh

Result on my system is:
filename:                         testdir/test.desktop
readName():                       TEST root           
readEntry( "Name" ):              TEST root           
readEntry( "Name", "default" ):   $(echo TEST $USER)  
icon:                             xmag                
noDisplay():                      True                
readEntry( "NoDisplay" ):         False               
readEntry( "NoDisplay", True ):   true
readEntry( "NoDisplay", False ):  true

dump:
[Desktop Entry]
Categories = X-SuSE-DesktopUtility;
Encoding = UTF-8
Exec = xmag
GenericName = Desktop Magnifier
Icon = xmag
Name = TEST root
NoDisplay = False
Type = Application
X-KDE-StartupNotify = false
X-SuSE-Unimportant = true
X-SuSE-translate = true

Explanation:
The test program sets KDEDIRS=$PWD/test/profile1
The Desktop-File test/profile1/share/applnk/testdir/test.desktop is evaluated.
The important entries are:
Name[$e]=$(echo TEST $USER)
NoDisplay[$e]=$(echo "X" >> /tmp/kde.log; echo False)

Name should result in "TEST root" (when called as root)
and (more important) NoDisplay should result into "False".

I've used this (with Hidden instead of NoDisplay) in KDE3,
to make an applications only visible if a specific file exists (eg. show application only in start menu if its config file exists)

Maybe, this bug is also related to https://bugs.kde.org/show_bug.cgi?id=197523
which have been solved on the application site instead of KConfig.

it would be helpful if you provided a minimal sample, without all the python indirections (i.e., a c++ program, preferably in form of a new testcase in the kconfig autotest. or alternatively a shell script which just uses kreadconfig4).

Created attachment 40463 [details]
NoDisplay=False

Created attachment 40464 [details]
NoDisplay=True

Created attachment 40465 [details]
NoDisplay[$e]=$(echo False)

sorry, I'm afraid I'm not able to do this. I'm not very skilled at C++ and KDE programming.
And kreadconfig is very limited. It is primarily intended for config, not desktop files. And when I use it with full path filename, it presents the correct results.

But I can provide another test case without further dependencies.
I'll add three desktop files as attachments. They are identical, except the NoDisplay entry:
1. NoDisplay=False
2. NoDisplay=True
3. NoDisplay[$e]=$(echo False)

copy them to your xdg-data-apps path (eg. /usr/share/applications/).
1 and 3 should get visible in the start menu. Unfortunally, this does not happen for test3:
test1: is visible (correct)
test2. is not visible (correct)
test3. is not visible (wrong!)

It seems, that the problem occours in KConfigGroup::readEntry with a boolean default value. This is what KDesktopFile::noDisplay calls.
I don't find a way to evalute to a false value if expand 
[$e] is used in Config files.

I've set $foo to "false" in environment and set NoDisplay[$e]=$foo
in a test Desktopfile

    const KConfigGroup group = kdf.group("Desktop Entry");

    qDebug() << "readEntry ( \"NoDisplay\", true ): " <<
            group.readEntry("NoDisplay", true);
    qDebug() << "readEntry ( \"NoDisplay\", false ): " <<
            group.readEntry("NoDisplay", false);
    qDebug() << "readEntry ( \"NoDisplay\", \"false\" ): " <<
            group.readEntry("NoDisplay", "false");

readEntry ( "NoDisplay", true ):  true
readEntry ( "NoDisplay", false ):  true
readEntry ( "NoDisplay", "false" ):  "false"

So it seems impossible to use the expand feature for boolean values.
I consider this as a bug.

Regards Holger

Created attachment 40613 [details]
TestProgram in C++

specify desktop file via the -f option.

# CMakeLists.txt 
project (kde4profile)
find_package(KDE4 REQUIRED)
include (KDE4Defaults)
include_directories(${KDE4_INCLUDES})
set(kde4profile_SRCS kde4profile.cpp)
kde4_add_executable(kde4profile ${kde4profile_SRCS})
target_link_libraries(kde4profile ${KDE4_KDEUI_LIBS})
install(TARGETS kde4profile ${INSTALL_TARGETS_DEFAULT_ARGS})

# test.desktop
[Desktop Entry]
X-SuSE-translate=true
X-SuSE-Unimportant=true
Categories=X-SuSE-DesktopUtility;
Encoding=UTF-8
Exec=xmag
Type=Application
Name[$e]=$foo
NoDisplay[$e]=$foo
GenericName=Desktop Magnifier
Icon[$e]=$foo
X-KDE-StartupNotify=false

This bug is a result of bug > 226314.
But if there is no solution for 226314 it would be
possible to change 
kdesktopfile.cpp:

bool KDesktopFile::noDisplay() const
{
    Q_D(const KDesktopFile);
    if (d->desktopGroup.readEntry("NoDisplay", false)) {
        return true;
    }
...

to

if (QString("false").compare(d->desktopGroup.readEntry("NoDisplay", "false")) == 0)

Created attachment 41291 [details]
Patch / Workaround to let DesktopFile NoDisplay setting work with expand feature

Workaround checked against OpenSUSE 11.2 Update Sources (4.3.5)

so i had a look at the code and deep into my memory ... the expansion stuff is an utter mess, and fixing it is in fact the first item in the TODO file.