Follow the red carpet around the corner. When you step on the blocks, they start to shrink. The one with the Devil Dantini is safe, however, so kill him and then take the side path to reach the other Devil Dantini and smash the crates for a Heart. The blocks reappear, so you can get any crystals that you missed. Head to the door after a couple more shrinking blocks. In the next room, all of the blocks shrink away as you jump up them, including the one in the corner, so turn quickly and keep going up the line to the end.
To defeat Fosley, wait for him to toss an Exploding Minion at you. All you have to do then is run away and cross one of the Launching Squares around the donut. When the Exploding Minion steps on it, he'll be tossed up back to Fosley and will destroy one of his balloons. Once all three are destroyed, it's all over.
Yippee! An image gallery for Fosley's Freaky Donut is available. Click here to access it.