Level up screen It's so pretty! Btw I'm hopping onto the Children of UR project's game for a bit to check it out and show some support. If anyone care to join me feel free!
Just tested that. If you drop the item when they come across you the item on the floor will disappear and it will be just like you had it in your inventory.
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(Downloaded snap since I haven't figured out flash-compatible screenshots on my system yet.)
By the way, what happens when a bandit is trying to steal some item from you and you drop it on the floor or otherwise get rid of it?