From the error message, I guess you are installing build 0803. The authentication mechanism to test the connection has been changed in this build. Essentially, you have to configure the kerberos delegation for the workspace account for this to work right.
Make sure you have the following done:
- Configure K2Server and K2HostServer SPNs on the K2 service account
- Create your Workspace account and configure delegation using kerberos protocol to the above 2 SPNs.
- Configure the Reporting Services site app pool account with RS service account.
- Configure the RS site to use kerberos using the adsutil.vbs command. i.e. cscript adsutil.vbs set w3svc/<RS site ID>/AuthenticationProviders "Negotiate,NTLM"
Once you got this done, click the Test connection button again and it should work.
If it doesn't, you might have missed something. To troubleshoot further, turn on Kerberos event logging and it will help give further clues.
I hope this helps.