What would this practically mean? That Legends mode would consist of folklore instead of a meticulous construction report?
Well, there's an extent to which this is an infrastructural idea. If entity knowledge of events was modeled in this way, many possible extension points (such as the ideas mentioned in my original post) present themselves for exploitation. Legends mode could be expanded, for example, to let you see the stories an entity knows and view their details.
In Adventure mode, this infrastructure would help entities tell you relevant things. Ask about local history and you'll hear from everyone in town about last year's goblin siege of the village down the river, and how the few survivors straggled to this neighboring settlement and shared their tale of woe. And of course, there will be those times when a story dies because no one was left alive to tell the tale.
In dwarf mode, existing and future ways in which dwarves express lore (engravings, etc.) would reflect their knowledge set. You'd be able to observe trends in storytelling. We already see some of this based on preference -- dwarves seem to love telling tales about local mayoral elections and such. Storytelling would enrich these trends. Merchants would come one year and share their stories; the next year, they could come back and you could sell them goods adorned with images based on those stories!
Another cool idea associated with this would be dwarven work songs. A happy dwarf might sing a song of lore while toiling away in his workshop. Other dwarves could learn the song (and story) by hearing it, and might react positively or negatively based on the content. And of course, there's that eternal threat of dwarven poetry...