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.

don't get scared right away, as at 5 and 7 I am assuming things are still innocent. you are right to be worried, but whether it is both girls or the opposite gender, this is also an age where kids start getting curious with their own and each other's bodies. instead of reprimanding or making them feel that they did something wrong, tell them that they can play their games but without removing or pulling up their clothes. tell them that it is not good manners to do so, so they should refrain from it. also, try and make them play in common rooms, where you or some other grown ups are present, instead of playing in a room with the door closed, even if partially.