Answer: you both are, but you are looking for different things. I hear this said so often that I though it would be a good idea to try to explain it .
1. There is a difference between verbal understanding and understanding the situation (situational understanding). Imagine you are in the middle of Russia but you only know a handful of words of Russian. You'd actually be OK most of the time as you would follow clues and cues, watch carefully what others were doing and follow, look at facial expression and body language including gestures. It would break down if someone asked you a question without any visual referent, no context or idea of what they were saying.
It's like this for children. If you say, 'we're going in the car' but you have the car keys in your hands, you could say, 'ibbly dibbly doo.' and get the same result:the child knows what's happening. If you say, 'Fetch your red shoes from your bedroom cupboard next to your bed,' and they come back with them, ask yourself which bit the child understood. If they always wear those shoes for going out and they're kept in the same place, then the word 'shoe' could perhaps be the trigger rather than anything extra. I'm not saying situational understanding is bad, it's just different to actually understanding the words. It is also a big strength because it shows the child is aware. Situational and verbal understanding together is what we aim for.
2. Information carrying words (ICW):
When we talk about information carrying words, we mean the number of words in a sentence or phrase which the child has to understand in order to be able to carry out the command. It's about the choices given (thank you to Jayne Waterman at Little People Nursery for that description). If I have a these pictures (from Black Sheep press Barrier games pack) and asked 'can you show me the little green ball?' They would only need 2 information carrying words as the choices are size and colour.
If we had the 2 sets of pictures and asked 'show me the little green ball' they now have 3 choices colour, size and object so the task is 3 information carrying words:
If we cut up those 2 sets of pictures and added the monkey and the flower:
The request 'put the little green ball on the monkey' would now be a choice of size, colour, object and place so 4 ICWs. This is school entry level!
We'll look at another example next time to make sure it's clear as it's such a great concept which gives you an understanding of where the child is but also how to tailor what you say to make it easier for the child to understand.