Adrienne Mayor argues that fossils were interpreted as the bones of heroes and monsters by classical Greek and Roman people. And most picturesquely that the distinctive nasal opening in the center of mammoth skulls may have inspired stories of cyclopes.

I read an earlier edition of the book some time ago, and it read a bit like pop-history to me; I'd be very interested to learn if there's a mainstream scholarly consensus about the hypothesis.

I asked a similar question recently. /u/mythoplokos gave a great answer. Cheers

About your side question: without a rigorous study of anatomy, it's very difficulty to interpret fossils in a way that actually reflects how they appeared in life. Even at the beginning of the modern period, dinosaur skeletons were recreated in ways that were laughably incorrect (compare Iguanadon and Iguanadon). This of course goes back further, for example in the middle ages a woolly rhino skull was discovered near klagenfurt and identified as a dragon skull. You can see the statue modeled on the skull here...note the odd head shape, inspired by the odd skull shape. Skeletons are almost always found in a jumble and with many parts missing, so it's easy to take a bone and fill in a mythical creature that has nothing to do with it, if you don't know what you are doing. But even in the rare cases where a nicely preserved skeleton was found people managed to totally misinterpret it. For example this salamander fossil that was interpreted in 1728 as a human killed in the flood (though to be fair people were doubting that interpretation by the 1760's--though the first doubter thought it was a catfish!).

Anyway, the point of this is that typically people don't so much derive their mythical creatures from fossils, but rather impose their own views on them. The lindwurm skull wasn't the origin of dragons, rather it was interpreted to fit the mold of preexisting dragon myths. Likewise with many other fossils. They tend to be supporting evidence rather than the origin, because they were a "blank slate" onto which almost any picture could be painted.