Although not stated on-screen, the scene took place in the Games Room, as confirmed in the Series VIII official script book.
Deleted scenes of the episode show Lister and Rimmer messing with the frozen Denton further, with Rimmer writing on Denton's face since he was seeing Rimmer's old flame Yvonne McGruder and Rimmer was jealous.
Since a Games Room is not mentioned until Series VIII, it is likely that the Games Room was another nanobot-created addition to the ship, along with other things such as the new Karaoke Bar. In earlier series, the gang were forced to make their own entertainment, such as playing "junior angler", "table golf", "jousting in the corridors with french loaves", and "Durex condom volleyball". ("Timeslides", Series III)