M.B.
Here are a couple ideas...
Kids love to decorate cookies. Make sugar cookies ahead of time and have them frost and decorate with sprinkles or other things. You can wrap them up and have them take them home as part of their favor. Another thought is having cupcakes instead of a cake and have them decorate a cupcake.
If you're planning to have a party bag with favors, have a paper bag that they can decorate themselves with stickers, crayons, markers, etc...