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I really don't think there's a wrong answer here, as long as the ruling is logical, fair, and consistently applied. In fact, by applying some hindrances, gaining combat advantages to overcome terrain difficulty becomes more important.

My own experience is that I tend not to apply hindrances to the players; I refrain from making the player's life more difficult for whatever reasons. But it should not be that way: hindraces allow also for more interesting options for the players, specially in broadening their weapon skills. For example, if a short sword will hit more often than a great axe in a smial or inside Mirkwood (lesser penalty due to lower Encumbrance), then dwarves will have a reason to develop their secondary weapons that, right now, is inexistent.