Good readers are able to correctly pronounce familiar words, whether they are regular or irregular words, and are able to pronounce unfamiliar words in a way consistent with the conventions of written English. For skilled readers, decoding is so automatic that it requires virtually no conscious effort, so the reader can devote full attention to the task of comprehending the text.
As mentioned earlier, oral reading accuracy (a.k.a. "running record") is one form of decoding assessment, but it is not a very "clean" assessment. Teachers need to be aware that, in their early attempts to acquire reading skills, children apply many different strategies, some of which are hard to detect. Children often attempt to guess words based on the context or on clues provided by pictures - most of the time, a child's guesses are inaccurate, and their difficulties with decoding are revealed, but sometimes the child guesses correctly, making the teacher believe that the child accurately decoded the word. Teachers who use oral reading as a decoding assessment need to pay careful attention to the child as she reads - teachers should be aware that the child may appear to decode some words because those words are in the child's sight-vocabulary, and the child may appear to know other words when she is really just guessing.
A cleaner test of decoding skill is to determine the child's ability to read words out of context. Isolated words can be presented to the child one at a time, and the child can be asked to say the words aloud (this is not a vocabulary test, so children should not be expected to provide meanings for the words). The words selected for a decoding test should be words that are within the child's spoken vocabulary, and should contain a mix of phonetically regular and irregular words.
Similarly, children can be asked to match a spoken word with a written word -- the teacher can say a word or a word part orally to the child, and the child can identify the written form that matches the spoken word or word part.
Children can be tested on their accuracy (Is each word pronounced correctly?), their fluency (How much does the child struggle with word naming?), or their "level" - leveled lists of words are provided by many publishers, and the child can be assessed as to his or her ability to decode words that are of varying difficulties.
Sometimes teachers test children's ability to "recognize" sight words as a test of decoding skill, but "recognizing" words is not the same as decoding them. Decoding is a strategy that readers can use on all words, even words they've never seen before. Sight-word reading has to do with memorizing the "image" of a word or a specific feature of a word, and with this strategy, only a select few words are learned. All children go through a stage as they learn to read where they memorize a few sight words, and sometimes they are even encouraged by teachers who use Dolch word lists and frequency indexes to focus the child's attention on the most useful sight words. However, memorizing sight words does not help a child to learn how to decode words, and testing the child's knowledge of specific, well-practiced sight words does not provide a measure of his or her decoding skill.