While uplaoding image on k2 item from admin UI, after clicking save, the following message is seen.

Notice

The image was not uploaded. Please ensure that you used a valid image file and that file uploads are properly configured on your server.

Issue is with k2 2.7.1 joomla 3.6.5 and php 7
same issue is not present with k2 2.7.1 joomla 3.6.5 and php 5.6

Is the GD library properly installed in your server?
Can you upload images from the media manager?

No cannot upload images from both
I wonder how the same works for php 5.6 which is the only difference

I might have mislead, I meant both media managers, K2 and the default one.

This might be related to the GD, a PHP misconfiguration or a multitude of reasons. If the default media manager fails, then you might need to stick with 5.6 (with this host).

Thank you for the info. reinstalling GD for php 7 fixed the issue

You 're welcome :)