What exactly is happening here, why is entropy created and why does
that make it irreversible?
For the irreversible isothermal expansion less work is done because less heat is taken from the hot reservoir. This also results in an increase in entropy of the surroundings for the cycle. However, in the case of an ideal gas, for both the reversible and irreversible expansions 100% of the heat that is taken from the hot reservoir is converted to work due to the first law.
The following is the explanation for the example of an ideal gas. Refer to the figure below. In the figure the irreversible process consists of the following:
At equilibrium state 1, visualize a vertically oriented piston/cylinder with a weight on top. That weight plus atmospheric pressure constitutes the initial external pressure on the system at state 1. It also equals the equilibrium pressure of the gas.
Now suddenly the weight is removed. The external pressure suddenly drops to the final external pressure $P_2$, but the internal pressure of the gas is not in equilibrium with the external pressure. Also, since the reduction in external pressure happens so quickly (non quasi-statically) it is an irreversible process and there is not enough time for heat to transfer to the gas, i.,e in effect it happens adiabatically.
Now after the weight is removed, the gas is allowed to expand (irreversibly, since the gas is not in equilibrium with the external pressure) until the gas comes into thermal equilibrium with the thermal reservoir of the surroundings, i.e., in equilibrium at state 2. We call this path isothermal because even though the gas is not in internal equilibrium, the temperature of the gas at the boundary with the surroundings equals the temperature of the thermal reservoir
For simplicity we will assume the three other processes in the cycle (2 adiabatic and isothermal compression) are reversible.
For both the reversible and irreversible expansions both the first and second laws must be satisfied.
First Law:
We start with the first law applied between equilibrium states 1 and 2, that is
$$\Delta U_{12}=Q_{in}-W_{out}$$
For an ideal gas, any process
$$\Delta U_{12}=nc_{v}\Delta T$$
Since both the reversible and irreversible paths begin and end at the same temperature, $\Delta T=0$ or $T_{1}=T_{2}=T_{h}$ where $T_h$ is the temperature of the hot reservoir. Therefor $\Delta U_{12}=0$ and for both paths
$$Q_{in}=W_{out}$$
From the figure we see that less work is done for the irreversible path (dark gray area) than the reversible path (light+dark gray areas), or
$$W_{out}(irr)\lt W_{out}(rev)$$
from which follows
$$Q_{in}(irr)\lt Q_{in}(rev)$$
So for the irreversible path less work is done because less heat is added, but still all of the heat added is converted to work per the first law.
The thermal efficiency for any heat engine cycle is the net work done divided by the gross heat input, or
$$\eta=\frac{W_{net}}{Q_{in}}=\frac{Q_{in}-Q_{out}}{Q_{in}}=1-\frac{Q_{out}}{Q_{in}}$$
Since $Q_{in}$ for the irreversible cycle is less than $Q_{in}$ for the reversible cycle whereas $Q_{out}$ is the same for both cycles (the isothermal compression being reversible), it follows that the efficiency of the irreversible cycle is less, or
$$\eta_{irr}\lt \eta_{rev}$$
Second Law:
For both the reversible and irreversible cycle, the change in entropy of the system is zero. That's because entropy, like internal energy, is a state property and the system begins and ends at the same equilibrium state. The change in entropy of the surroundings is the sum of the changes in entropy of the reservoirs.
For the reversible cycle where $T_c$ and $T_h$ are the temperatures of the cold and hot reservoirs,
$$\Delta S_{surr}(rev)=\Delta S_{cold}+\Delta S_{hot}=0$$
$$\Delta S_{surr}(rev)=\frac{Q_{out}(rev)}{T_{c}}-\frac{Q_{in}(rev)}{T_h}=0$$
For the irreversible cycle, since $Q_{in}(irr)\lt Q_{in}(rev)$
$$\Delta S_{surr}(irr)=\frac{Q_{out}(rev)}{T_{c}}-\frac{Q_{in}(irr)}{T_h}\gt 0$$
The increase in the entropy of the surroundings for the irreversible cycle equals the entropy created during the irreversible isothermal expansion.
Hope this helps.