I had to refactor this article because it didn’t make as much sense as now in my mind when I first wrote it. This is now split in two with a main post being this one. Hopefully it will be more understandable for everyone!
You have associated an entry template to a folder, or the ObjectStore itself. You tried to add a document into a subfolders, but your entry template never appears in the selection list of entry templates. If you go into the properties of the subfolders to see if the entry templates are correctly inherited, you can see either an empty list, or it says there are inherited entry templates but the File Types are really strange and error is displayed. Here are what you see and what you were expecting to see.
Here is a video describing the problem, so you can understand better.