IMac G5 PowerPC boots up and freezes at light-blue screen

PowerPC G5 20" iMac, 2.0GHz, +260 GB harddrive, 2 GB of DDR SDRAM
Leopard OS 10.5.6
Computer starts up and freezes at light-blue screen. Mouse still moves, bu no keyboard commands work. Only holding the power button will shut down the computer.
Tried the following:
- Able to boot into Safe-mode only.
- Ran OS Disk Utility to repair permissions and also MacTuneUp 3.6.0, and no change
- Tried changing start-up to boot from OS 10.5.6 DVD and still freezes with light-blue screen. Safe-mode allowed me to run Disk Utility but no difference.
- If I leave the frozen light-blue screen, eventually the iMac power-saving mode darkens the screen, until I move the mouse (then light-blue again and still frozen).
- I left my iPhone connected to the iMac, and when starting up the computer the iPhone started charging. When the light blue screen froze the iPhone stopped charging.
- tried starting computer with Options + Command keys
- tried + Options-Command-P-R untill you hear two beeps: Reset NVRAM (restart 3x)
- tried Resetting the SMU > Unplug all cables from the computer, including the power cord. > Wait 10 seconds.> Plug in the power cord while simultaneously pressing and holding the power button on the back of the computer. > Let go of the power button. > Press the power button once more to start up your iMac.
Questions:
> When booting from OS 10.5.6 DVD, Should I run Time Machine Restore system from Backup?
> I can work fine in Safe-mode all day, but limited resources. Is this a software or hardware issue?

Based on what you have you tried I would guess it is hardware problem.
First iMac's without camera and with GeForce FX 5200 graphics card are known of having capacitor failures which can cause the machine either to become unstable in different situations or fail to boot up at all. I have repaired many of them and changing capacitors brought completedly dead iMac (no power, no nothing) up to life so capacitors mean a lot.
Second and third it's mainly the graphics card which fails, causing the machine to fail to boot, become unstable or boot with artifact patterns in picture.
There has also been power supply issues and Apple did issue a recall back then, I think you can still find article about it and check if your machine has serial number which fits to that recall problem. This way you could check if you should suspect power supply going bad.
Capacitor problem is usually easy to identify (open up the case and look if those can-like things are bulging or swollen) and quite easy to repair if you have bit experience in computers and soldering, iFixit.com provides great disassembly instructions. Graphics card problem is harder to identify because in that case it is the solder which breaks under the graphic chip so you cannot actually see the defect. It is also harder to repair atleast if you want the machine to work long time after that repair. Basically you would need to heat the GPU enough to reflow solder connections.
Because the machine can boot into safe mode I'm suspecting that you have some of these issues I described, safe mode does not utilize hardware at full power and disable full graphics acceleration for example.

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