I am not sure on how begin.
Which microcontroller or development board should I use ?
Is it possible to do both mp3 or wav recording of an audio signal and storing on USB Flash Drive using a single microcontroller?If yes ,how do i go about doing it?
If storing on USB Flash Drive is complicated I don't mind using SD/MMC cards.
The audio processing in that link is affecting the audio data. It is not converting the audio data to MP3 or wav format.
Do you know how to do that? Can you do it fast enough to keep up with the incoming audio data?
By the time you buy an Arduino, a USB Host shield, a microphone and audio amplifier, and batteries to power it all, it will be bigger and more expensive than buying a recorder.
You can use another ARM chip with USB host capability if you want to use USB mass storage disks instead, I think a LPC1768 may be a good starting point as opposed to the AT91SAM7, try a mbed
Don't know how close to your requirements this might be, but I couldn't resist it at that price, so I ordered one a week ago. Hasn't arrived yet so I can't give you a review.