Hmm, I have a Kindle 4 and my collections work correctly. At the very top of your screen, make sure you're sorting "by collections" (top right should say that). If not, highlight the area and tab over until you see it and select. Once you have it selected, only the items that aren't in collections will be showing individually.
I think that's the one I have too, and I also can organise things by collections. If you have a problem where within your collections, despite the option for things to be ordered by latest read is on, your latest item read is going to the end of the list rather than the beginning, it may be because you've recently reset your device. You should check that the time is set correctly, and should hit the 'Synch' option, and that should fix the problem.
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