I noticed that my kid and her cousin play some doctor game where she had raised her t-shirt. As soon as entered they got scared and tried to cover up all. What does all this mean and how to deal with the situation? They both are 5 and 7 respectively.

I am sure it must be innocent playing. Because right now they are too young to think from the sexual point of view. They are only role playing what they have seen at the doctor's themselves. Do not make a big deal about it just handle the situation calmly by a explaining that they are only pretend playing so there is no need to remove clothes.