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So if I set my lot cost item to "average" is it using the average of the lot?

If you set it to average - the same cost is calculated for all lots at any given point. If you have it set to Lot - then the lot is costed using the average cost of the individual lot.

i.e. (assume each quantity is 1 for simplicity)

Lot 123: $1
Lot 123: $2
Lot 234: $30

Under Lot costing - your average cost for lot 123 would be $1.50 and for 234 would be $30

Under Average Costing - your average cost for both lots would be closer to $10.

of course - this is *grossly oversimplified, and there's more involved, but this gets the effective point accross

Makes sense, thanks.  The help verbiage on the item field is a little misleading IMO.