For a fully hardened steel material, hole surface microstructures are often subject to microstructural transition because of the intense thermomechanical loading. A white layer can be formed on the surface of a drilled hole of hardened carbon steels, which results from two mechanisms: thermally driven phase transformation and mechanical grain refinement due to severe plastic deformation. In this study, a multistep numerical analysis is conducted to investigate the potential mechanism of surface microstructure alterations in hard drilling. First, three-dimensional (3D) finite element (FE) simulations are performed using a relative coarse mesh with advantedge for hard drilling of AISI 1060 steel to achieve the steady-state solution for thermal and deformation fields. Defining the initial condition of the cutting zone using the 3D simulation results, a multiphysics model is then implemented in two-dimensional (2D) coupled Eulerian–Lagrangian (CEL) FE analysis in abaqus to model both phase transformation and grain refinement at a fine mesh to comprehend the surface microstructure alteration. Experimental results are used to demonstrate the capability of this multiphysics model to predict critical surface microstructural attributes.