All you need is an image that is 16x16 and you would want it as a .png image. I use www.iconspedia.com to find some good ones or use a famfamfam icon which are great as well. Then, just name it favicon.ico and place it in your 'root' directory and you're good
We used a small TV icon on TeeVeeTown.com from the famfamfam icon set and it works great for us, easy and done
Your site logo seems to be a smiley. Have you looked at smilies out there for one that might be close to your logo? Creating a 16 x 16 image is really difficult.
This is the normal program I use for doing things like cropping, resizing, re-sampling, and even taking images and making them ico files. Works for me. http://www.irfanview.com/