Your friend’s son-in-law’s antics are inappropriate for a variety of reasons. First, this was at best a severe lapse in judgment on the son-in-law’s part by not thinking things through and wrongly thinking this was entertaining. At worst this is horrible parenting and your friend’s response to this was exceptionally good and intuitively correct. He undid the confusion and hurt with the right words and gestures. Helping them to counteract the moment and move past it was the best possible intervention.
Children are resilient and forgiving — so I wouldn’t worry so much about this one instance as I would about the fact that it may be emblematic of a father who can’t understand the impact such a lyric and behavior could have on children this age. If he did this it means his social and emotional intelligence are lacking. The children’s reaction is proof of this in itself.
I’d encourage your friend to honor his instinct and to find a way to talk to his son-in-law. This should not go unchecked as doing so is likely to lead to more of the same.