Yes the ECU is bypassed. The ignition timing advance that was electronically controlled will now be controlled entirely with the vacuum advance/mechanical advance distributor and Duraspark module. The ECU will not be needed.
Here is a picture of the overall layout for the Duraspark TFI method:
Ford Duraspark 2 Ignition System
The Ford Duraspark II electronic ignition system will improve your throttle response, horsepower, and gas mileage over a points type system. Not to mention it is maintenance free. The Duraspark II system was used on all small blocks starting in 1977. The system will give a very hot and consistent spark good to about 350+ naturally aspirated horsepower and also works well up to about a 150 HP shot of nitrous. This article is designed to show you what pieces go together and give some tips on hooking it up.
The ignition system is comprised of four basic components - the distributor, ignition module, the coil, and the wiring harness.
First the distributor, the key here is to get a distributor that is compatible with your cam type, has vacuum advance, and has a decent mechanical advance curve. What this means is if your using a roller cam you need a steel gear - see the Ford Motorsport catalog or just use an '85 Mustang 5.0L GT distributor for a 5-speed. I paid about $90 for mine from the Ford dealer rebuilt. Also the '85 Mustang distributor has vacuum advance and a great advance curve straight from the factory. If you are using a flat tappet cam your first choice should be an '82-'84 5.0L Mustang HO distributor. This distributor also has vacuum advance and a good curve. In the end any '77-'84 302 distributor will work with as long as the car was carbureted (NO CFI - throttle body injection), just don't forget to use a drive gear that is compatible with your cam. Get your distributor advance recurved as follows: centrifugal advance - 0° @ 1,300 rpm, 11° @ 2,000 rpm, 20° @ 5,000 rpm; vacuum advance - 0° @ 4.5" Hg, 11.5° @ 8" Hg, 20° @ 12.5" Hg.
Okay, so what's the big deal about vacuum advance? How about your gas mileage - with a vacuum advance distributor your gas mileage will be significantly higher than with a mechanical advance distributor alone. If it is a strip only car then it won't matter - vacuum or mechanical.
Ignition Module - This is really pretty simple - get the one with the blue color plastic where the wires go into the module. When mounting to the fender-well be sure it is grounded good and away from high temperatures (exhaust and motor). Heat is what kills electronics so a little prevention up front will go a long way.
The coil - Just about any coil will work but stick to the good stuff - Accel, MSD, Mallory, or Jacobs for the best results. Once again, mount on the fender-well away from heat for the longest life.
Wiring Harness - It is always easiest to use the factory harness with the factory connections, but be careful, I have had to chase many problems due to failed factory connections, the best bet is to clip out all connections and solder wires together once you know the wiring is right. Follow the diagram below for hooking up.
Odds and Ends - For the distributor cap and rotor be sure to use a cap with brass terminals and large diameter (1977 or later).
Above info from: Fletch's Carbureted 5.0 Mustang site: http://www.jason.fletcher.net/tech/duraspark/duraspark.htm
He also has a page about converting a Mustang from fuel injection to carburetion, worth a read, it might help you work through the conversion even though some info is Mustang specific: http://www.jason.fletcher.net/tech/efi-carb/efi-carb.htm