We introduce a computational theory of situated language understanding in which the meaning of words and utterances depends on the physical environment and the goals and plans of communication partners. According to the theory, concepts that ground linguistic meaning are neither internal nor external to language users, but instead span the objective-subjective boundary. To model the possible interactions between subject and object, the theory relies on the notion of perceived affordances: structured units of interaction that can be used for prediction at multiple levels of abstraction. Language understanding is treated as a process of filtering perceived affordances. The theory accounts for many aspects of the situated nature of human language use and provides a unified solution to a number of demands on any theory of language understanding including conceptual combination, prototypicality effects, and the generative nature of lexical items.