In the night garden theory
I see my kids watching this show all the time. The show seems to be bookended by segments in which Iggle Piggle (the little blue retarded looking character), goes to sleep in his little sail boat as the narrator tells us that he is deep in the ocean and far away from land. The narrator also tells us in a reassuring voice that he is "safe".
The shows intro: http://www.youtube.com/watch?v=NQ5ku4z1pjs
Does that boat look like it has enough provisions to get him going wherever it is that he is going? He doesn't even have a second blanket, and uses his sail as one at night.
So what my theory is, is that Iggle Piggle is dying from dehydration and the events of each episode take place in his mind. As his boat floats about the ocean, the stars start turning into flowers and shit, and he imagines himself in this happy garden with his friends, who i'm not too sure ever existed in the first place.
The ending is what really puts the nail in the coffin. The reassuring narrator (edit: Who I just found out is Derek Jacobi... aka THE MASTER!) comes back to tell everyone to go to sleep, and that Iggle Piggle isn't asleep and that it is time for him to go. As seen by this video (http://www.youtube.com/watch?v=avk02oFGG_k), kids react to this ending poorly.
Kids are very emphatic, and understand what is going on sometimes better than adults, which is why they get upset at this ending... they know Iggle Piggle is dying and he is most likely dead by the end of the episode. They might not understand why they are getting upset, but for some reason, they know that this ending is upsetting and wrong.
Iggle Piggle then floats off into the darkness of the ocean, "asleep".