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.

Are both of them girls or is the cousin a boy? This is a delicate situation, I reckon that you ought to approach this situation with care. Chances are, they were simply playing and meant no harm or malicious intent. At 5 and 7 years, they are at an age where they are fascinated with their bodies. At their age and stage in development, they are naturally curious, I honestly do not think they have any inkling of being sexual. "Playing doctor" is just another way of exploring and learning more about their own bodies. If this bothers you, perhaps you can talk to your daughter and her cousin, tell them you understand that they are curious but they need to leave their clothes on because of modesty and privacy. If they are indeed curious about the human body, you can consider getting them a book or a toy that will help educate them about body parts and anatomy.