The objective of the present paper is to propose a new FEM analysis method which takes the phase transformation and the tempering effect into account. We developed an algorithm in which the tempering effect, that is shrinkage and mechanical properties change, is represented by the change of carbon concentration. The proposed FEM analysis method correctly estimates the volume shrinkage phenomenon during tempering. This method is applied to the evaluation of residual stress in a steel block subjected to locally heating and its variation due to tempering. The calculate results well explain the change of residual stress due to tempering than the conventional quenching simulation code, and the advantage of the proposed method is confirmed.