The idea for the cake sounds lovely.
For the lolly bag, you could always make some playdough and put it in a bag with a cookie cutter. Depends on the ages of the littlies though. Another idea would be some rubber ducks or other cheap bath toys.
Another idea would be to make a big cookie on a paddle pop stick - and have the childs initial on it - either in icing or lollies. You could wrap it in a bag and make it look pretty
Have fun!! ( I love doing the kids parties )