What does the 'and a Barbarian together' part mean in point 1. Does it mean to place a settlement and a Barbarian unit in that single city?
Yes. Place the barbarian in the barbarian settlement that you just placed.
And where should the Barbarian unit be placed in step 2, does it imply that I can place the Barbarian unit in ANY city on the map, including one that is further away than 2 distance from my cities?
Place the barbarian in any barbarian settlement (obeying stacking limits).