The "Cow Level" in Diablo first began its life as a rumor on Diablo's Battle.net community over a decade ago. The rumor was made up in a thread where players discussed secrets and hidden locations in Diablo. Whoever came up with it included a photoshopped screenshot, and so the story spread.
The rumor was so popular that in the official expansion to Diablo, Hellfire, paid tribute to it by including a character dressed as a cow in the northeast of Tristram. Diablo II went a step further and included an actual cow level, which could be accessed by combining a Tome of Town Portal and Wirt's Leg (found in the ruins of Tristram in Act 1) in the Horadric Cube.
Diablo's popularity helped the Cow Level to become a part of gaming history, which has since been given tribute in World of Warcraft as a unique item (the Cow King's Hides), among other things.
The recently released Diablo III does not have a Cow Level. It even says so during the loading screen when you join a new game sometimes. But what it does have is something even better—Whimsyshire.
Whimsyshire is a land very much inspired by the My Little Pony craze and the complaints from fans about the game's supposed "rainbows and unicorns" color palette early on in Diablo III's development.
To get to it, you'll have to pick up a number of secret items:
Black Mushroom – Tristram Cathedral, Act 1
Leoric's Shinbone – Leoric's Manor, Act 1. You can find it in the fireplace in the room to the right.
Wirt's Bell – From Squirt, a merchant in Act 2. She's a little girl in the Caldeum Bazaar.
Liquid Rainbow – Found in the Mysterious Cave in Act 2. You'll have to open a "Mysterious Chest" to get it. The cave is located in the Dahlgur Oasis.
Gibbering Gemstone – A rare monster called Chiltara in the Caverns of Frost, Act 3.
Blacksmith Plans, Staff of Herding – Finally, you'll need to get the blacksmith plans for Staff of Herding. Izual has a chance of dropping them.
When you're done assembling it, just head on over to Old Tristram and look for the skeleton of a cow. A ghost will then speak to you and unlock Whimsyshire.
Here's a video of what it looks like.