In order to understand the Catholic Teaching on Penance and Indulgences let us use a practical example from ordinary life to illustrate what is taking place. One might call this a parable of sorts:
We have a family (a husband, wife and child) that live together on a small farm. The husband is called away by his Father for an extended visit, leaving the wife and child to run the household in his absence.
The husband issues some instructions before his departure. To the wife he says: “You will be in charge during my absence. Do as I have taught you. Whatever decisions you make will be honored by me.”
To the child he says: “Your mother will be in charge while I am gone. Do as she says and obey these simple rules that I will now give you in the presence of your mother.”
Let us say that among these rules is a forbiddance to drive his tractor. Some time later, the child, knowingly violates that rule. The child drives the tractor into a ravine and breaks the axle. The mother is told of this occurrence and because of the tears and sobbing of the child, forgives the child for the disobedience. However, to make things right, justice needs also to be served. Therefore, the mother (fully aware of the husband’s sense of justice and his unprecedented mercy) wisely tells the child to get a job at a neighbor’s farm in order to pay back the price of the broken axle. The child would then have the tractor restored to the original condition as soon as practicable.
The child, showing remorse and the best of intentions, begins working in order to save the money necessary for the repairs. However, the mother, in her mercy, sees that the child is working as hard as possible and may get discouraged by the task. Therefore, exercising her mercy (knowing full-well the mercy that her husband would show), relieves the child of the duty of working at the neighbor’s farm and instead gives the child a few simple chores around their own home instead.
The mother then goes to the bank and withdraws a sum of money from the family’s savings. This is comprised mostly of the money that her husband has earned but partly from the inheritance of relatives that had passed away. This money is mercifully used to repair the tractor and to restore the child to the condition that the child was in before the unfortunate mishap. But the child must accomplish the few menial chores around the house as specified to receive the benefit.
Now the husband, in the above story represents Christ while His Spouse, the Wife, is the Church as established before Christ’s departure from our midst. The child is, of course, the members of the Church. Since Christ told his Apostles that whatever they bind and whatever they loose would be bound and loosed in heaven, the Church has the right, as did the wife, to exercise this power in the absence of her Spouse. She first, exacted a fair penance for the misdeed in accordance to the justice that was due. Secondly, she exacted mercy, in the name of her husband, to lighten the burden on the child while applying the merit (money in this case) as accumulated by her husband and those close relatives who left their money to the estate. Now the Church too has an estate and can use the merits gained by Christ and the saints (His brothers and sisters) to be applied to souls for their aid and comfort.
 “Amen I say to you, whatsoever you shall bind upon earth, shall be bound also in heaven: and whatsoever you shall loose upon earth, shall be loosed also in heaven.” __ Matthew 18:18