How to create a menu with background images for list items?
I would suggest:


Use the module http://drupal.org/project/menu_attributes (beta 1 is out for Drupal 7)
Give each menu item a CSS ID or class that needs an image
Use CSS to assign background images to the menu items


Using this method, no PHP coding is required, and the menu images become content editable by your authors (once the CSS images have been setup).