Desnik
As you said, the parents are still a wreck. They are probably barely holding together themselves and can't deal with much now. Since the dog is no imminent danger, they just put the dog in the garage until they can deal with it.
But, as the two gals are sleeping in the living room, it IS because they fear the dog will get in there again and go after them.
Because the parents are a wreck and thinking about the nose, they probably haven't realized how much M has been affected. It probably didn't occur to them that she saw the majority of it. I'm glad you got to be there for her.
Yes, BOTH children need some counseling. Even though the one girl got bit by a dog she knows, which might make it less traumatic than if it was a random dog, she has been affected more than she seems to be letting on. She might also be holding back, of she fears her dad might do something to the dog.
The dog needs to go. Right away. It would better for both the girls. Maybe then, the girl can let out her real feelings.
Observing it from where you are, it might be helpful to the parents to mention what you are noticing and what M had said to you. They are probably overwhelmed right now. Someone outside of this saying to them, in essence, "You need to look at this over here," might be what they need.