Peter Haddley, 26, said he and Colin Coats were friends while prisoners in Addiewell jail, West Lothian, after Coats was arrested on suspicion of murdering Lynda Spence, who disappeared in April 2011.
Mr Haddley said Coats told him he had "cut off her head" and he had to increase the temperature of the furnace he had put her body in because there was "still parts of it left".
At the High Court in Glasgow – where Coats, 42, is on trial along with three co-accused, Paul Smith, 47, David Parker, 38, and Philip Wade, 42 – the witness also said he was asked to arrange a reported sighting of Ms Spence in Manchester.
The four men deny kidnapping Ms Spence, 27, holding her at a flat in West Kilbride, North Ayrshire, and torturing her before murdering her.
Mr Haddley said he and Coats exchanged letters which were written in code, referring to their arrangement to organise a sighting of the missing woman as "the game".
Solicitor general Lesley Thomson, prosecuting, asked Mr Haddley what Coats told him about Ms Spence.
He replied: "I was told he had killed her in a flat and disposed of her body in a furnace."
Mr Haddley said he was to get in touch with a solicitor he knew and ask him to report a sighting of Lynda Spence in Manchester.
He told the court that although he agreed to do it, he took no steps to make the arrangement.
Letters exchanged between the two prisoners were later seized by police.
The trial before Lord Pentland continues.